M&A vs VC: nemesis will follow hubris

There seems to be an inverse proportion between confidence levels and failure but it is hard to decide which are coming off worse – investment bankers and mergers and acquisitions teams or venture investors.

Both sets seem to have spectacular levels of self-confidence and self-promotion even if the reality of their achievements are thin and could in large part be put down to luck.

M&A has long been castigated for its estimated 85% of deals that fail to live up to expectations. Or, judged another way from a report in this weekend’s Financial Times, investment bank Houlihan Lokey calculates that, over the past four years, Europe’s 600 biggest companies wrote off €219bn ($250bn) of €1.6 trillion they spent buying businesses.

And as the FT points out: “Since the full horror of the dud acquisition can take several years to emerge, that [write-off number] probably understates the true overpayment.”

Write-offs and deals using offshore cash can help a tax management strategy – but it is still a large number to be giving away to third parties rather than to the government.

But venture investors have similarly struggled. The Wall Street Journal earlier in the week picked up on research by Shikhar Ghosh, a senior lecturer at Harvard Business School, that about three-quarters of venture-backed firms in the US fail to return investors’ capital.

His findings are based on data from more than 2,000 companies that received venture funding, generally at least $1m, from 2004 through 2010, the WSJ said.

But, as with write-offs there is a graduation of pain, from absolute melt-down to missed targets.

According to the WSJ write-up: “If failure means liquidating all assets, with investors losing all their money, an estimated 30% to 40% of high potential US start-ups fail, he [Ghosh] says.

“If failure is defined as failing to see the projected return on investment—say, a specific revenue growth rate or date to break even on cash flow—then more than 95% of start-ups fail, based on Mr. Ghosh’s research.”

In a nice follow-up, the WSJ added that of all American companies, about 60% of start-ups survive to age three and roughly 35% survive to age 10, according to separate studies by the US Bureau of Labor Statistics and the Ewing Marion Kauffman Foundation.

Where corporate venturing deals fit into the picture is hard to tell currently but given most of them are in syndicates with VCs, the results are probably similarly dire overall, albeit with a few bright sparks of hope.

Data provider Dow Jones VentureSource in the June issue of Global Corporate Venturing said corporations were in nearly a third of venture syndicates – 46 of 167 – backing a healthcare portfolio company that made an exit last year, and research by London Business School academic Gary Dushnitsky presented in a keynote talk at our Symposium last year has found corporate venturing outperform their independent peers.

Corporate venturing units’ task is made more complicated by the strategic metrics they use, which can be hard to measure but can potentially bolster the case for a deal even if financially the returns have limited.

But if there is a degree more realism about the financial aspect then, overall, this is likely to be better for the industry. If likely financial failure means groups that will run scared of any significant loss of capital will avoid setting up a programme only to close it a few years later as the red ink starts to flow then that is probably better.

This will mean the more committed and realistic corporate venturers and their parents will stand out more and those about to start will think harder about what they hope to gain.

After all, Nemesis only follows Hubris, whereas the meek and humble inherited the earth.